The Real Fiscal Cliff (2017 Update): Interest Payments on the National Debt

Apr 09, 2017

Back in 2013, the so-called “Fiscal Cliff” was the rage which described a situation where expiring tax cuts and spending cuts would conspire to send the economy into a recession. Of course, this had to be avoided at all costs so some taxes were increased and spending cuts reduced. Phew, the end of the world narrowly avoided.

Well, not quite. Federal policymakers are prone to extreme myopia. Had nothing happened to avert the Fiscal Cliff, the economy may have had some heartburn for a few quarters, but life would have gone on. All the while, a much bigger Fiscal Cliff looms over the horizon—a decades long horizon.

Unfortunately, a single decade to politicians might as well be a life-time. That’s another 5 elections for members of the U.S. House and another term and a half for members of the U.S. Senate. The current crop of politicians could be long gone before the Real Fiscal Cliff arrives. So, it goes unreported and unnoticed by most.

Imagine a household that is using their credit card to pay for everyday expenses. Then one day, this household discovers that they are borrowing just to pay the interest on their credit card debt. They are trapped and unless they significantly grow their income there is only one other way out—bankruptcy.

This is the very scenario that Uncle Sam is facing within the decade. Here is how we have gotten into this mess. According to The 2017 Long-Term Budget Outlook from the Congressional Budget Office (pdf), Uncle Sam is simply unable to contain his profligate spending with red ink as far as the eye can see. As shown in Figure 1, between 2017 and 2047, the federal deficit will grow from 2.9 percent of Gross Domestic Product (GDP) to 9.8 percent.

The growth in the national debt combined with projected increases in the interest rate means that the interest paid on the national debt is set to explode. Even the CBO warns:

“Pressure on the Budget Arising From Higher Interest Costs. Under CBO’s extended baseline, rising interest rates and increased federal borrowing boost net interest costs substantially, such that by 2044 they surpass discretionary spending for the first time since 1962, the earliest year for which relevant data are available. (Current net interest costs are relatively small because interest rates have been so low.) As slack in the economy continues to diminish, CBO projects that the Federal Reserve will continue to reduce support for economic growth and that interest rates would rise to levels consistent with factors such as productivity growth, the demand for investment, and federal deficits. Interest costs under the extended baseline are much higher than they would be with smaller deficits and lower interest rates.” [emphasis added]

Wow, let the second sentence about interest payments sink in for a moment . . . “by 2044 they surpass discretionary spending for the first since 1962.” That means Uncle Sam will be spending more in 2044 on interest payments than on spending items such as the military, transportation, space exploration, etc.

But wait, there’s more! The CBO neglects to mention what happens if interest rates go even higher than they predict. As shown in Chart 1, interest payments would be significantly higher with higher interest rates.

Under the current CBO forecast, interest payments will grow to $3.8 trillion in 2047 from a mere $269 billion in 2017—for a total interest bill of $44.6 trillion. However, if CBO is wrong and interest rates are 1 percentage point higher over this timespan, add another $12.3 trillion onto the interest bill—a 28 percent increase (see note below for important details). What if interest rates are 2 percentage points higher . . .

This, folks, is the Real Fiscal Cliff.

And, of course, the marketplace will take notice of the fact that interest payments are becoming a greater and greater share of the annual budget deficit. As such, the chances of economy crushing tax hikes or default will grow as well. The market will demand compensation in the form of higher interest rates on government securities. Higher interest rates lead to bigger budget deficits leading to higher interest rates . . . well, you can see where this is going.

The only hope we have of stopping this runaway train is to cut federal spending NOW. Not tomorrow, next week or next year, but right NOW. And cut until the budget deficit becomes a sustainable budget surplus without tax increases. Sure the economy may slow down and may even go into a recession. That pales in comparison to what will happen when Uncle Sam hits the interest payment wall.

Finally, all of this federal taxing and spending has geographical consequences. Check out our federal tax and spending app to see if your state is a net winner or loser. The video below shows a quick summation over time.

J. Scott Moody

Scott has nearly 20 years of experience as a public policy economist. He is the author, co-author and editor of over 180 studies and books. His professional experience also includes positions at the American Conservative Union Foundation, Granite Institute, Federalism In Action, Maine Heritage Policy Center, Tax Foundation, and Heritage Foundation.